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What is value investing? Warren Buffett’s strategy explained

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Value investors are always on the hunt for bargain stocks that appear to be trading for less than their ‘intrinsic’ or book value.

© Stockhead Australia Warren Buffett value investing

It is similar to contrarian investing, which involves buying and selling in an opposite direction to the general market sentiment.

Value investors, like contrarians, do not go along with the crowd. Trendy stocks are not something value investors acquire since they are usually overpriced.

At its core, value investors believe the market overreacts to both good and bad news, resulting in stock price movements that do not correspond to a company or entire sector’s long-term fundamentals.

Like gold or oil and gas, for example.

 

These irrational swings offer opportunity to profit by buying stocks at discounted prices.

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Berkshire Hathaway boss Warren Buffett is probably the best-known value investor today.

In 2002 and 2003 Berkshire bought 1.3% of PetroChina for $488 million, a price that valued the entire business at about $37 billion.

Buffett felt the company was worth about $100 billion at the time.

“By 2007, two factors had materially increased its value: the price of oil had climbed significantly, and PetroChina’s management had done a great job in building oil and gas reserves,” he told shareholders in 2007.

“In the second half of last year, the market value of the company rose to $275 billion, about what we thought it was worth compared to other giant oil companies. So, we sold our holdings for $4 billion.”

But measuring a stock’s intrinsic value — a mix of financial research and more fundamental elements like the company’s brand, business strategy, and target market — is tough.

Everyone would be rich like Buffett, otherwise. Even Buffett makes mistakes.

“A line from Bobby Bare’s country song explains what too often happens with acquisitions,” he says.“I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.”

 

When is a stock or sector undervalued?

Wilton Risenhoover, CEO of Fintel.io, says stocks may be overpriced or under-priced for several different reasons.

“For example, if the economy is doing poorly and investors are panicking and selling, a company may be undervalued,” he says.

That was certainly the case during the COVID flash crash of March 2020, or the unexpected war in oil markets which saw prices briefly go into negative territory.

Oil and gas prices are currently soaring, and the ASX 200 index comfortably surpassed its February 2020 high in May this year.

© Provided by Stockhead ASX 200 over the past 5 years.

Investors who ‘bought the dip’ would be sitting pretty.

“Another reason why stocks may be cheap is that the public is unaware of them due to insufficient coverage by analysts and the media,” Risenhoover says.

“News like disappointing or unexpected earnings releases, product recalls, and lawsuits, psychological biases may [also] drive the stock price up or down.

“Value investors re-examine well-known stock names whose values have fallen, thinking that these firms may recover from setbacks provided their fundamentals are sound and their goods and services are still of high quality.

“The long-term rewards for investors who acquire and hold these bargain equities may be very substantial.”

 

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